The first quarter 2012-13 policy review of the RBI has cast more doubts on the trajectory of both growth and inflation. The central bank has lowered growth forecasts for 2012-13 from 7.3% to 6.5% while its has upped inflation estimates from 6.5% to 7%. In revising the macro forecasts, RBI has left policy rates unchanged except the SLR (Statutory Liquidity Ratio), which it has reduced by 1% from 24% to 23%.
The question is what has this policy done, either to temper the growth fall or to bring down inflation expectations? Nothing. Policy rates are maintained status quo leading to interest rates staying at higher levels. The SLR cut will only serve to take up government bond yields and nothing else. If RBI was expecting banks to stop buying government bonds at a time when the government is borrowing Rs 15,000 crores on a weekly basis and lend to the economy, it is hugely mistaken.
The higher government bond yields due to the SLR cut will attract more bank money as banks especially public sector banks have no appetite to lend to the economy given the rising NPA’s. The first quarter 2012-13 results of public sector banks have seen their NPA’s rise on the back of more loans going bad due to a weakening economy. The banking aggregates data in RBI ‘s weekly statistical supplement shows aggregate deposits rising by an absolute amount of Rs 1,09,270 crores and bank credit growing by Rs 19,650 crores in the 30th March 2012 to 13th June 2012 period. Banks are parking money in government bonds as seen by the Rs 1,50,850 crores of investments in government bonds in the same period.
Banks are sitting on SLR levels of over 27%, which is over 3% from the regulatory limit of 24%. The reason banks are maintaining higher SLR is that the excess SLR gives access to liquidity from the RBI repo window. Banks are also credit averse as seen by the low credit growth seen fiscal year to date. The year on year credit growth number of 17.7% does not paint a true picture of credit demand as it was largely due to a spike in credit growth in the financial year end where banks dress up balance sheets.
RBI has highlighted the lack of investment demand in its policy report. The aggregate project cost envisaged from the new projects sanctioned financial assistance by banks and financial institutions, was Rs 210,000 crores in 2011-12 down from Rs 390,000 crores seen in the previous year . RBI has also mentioned the slowdown in growth in total consumption expenditure from 8.5% growth seen in to 2010-11 to 5.4% in 2011-2. The slowdown was led by private consumption expenditure growth from levels of 4.8% in 2010-11 to 3.2% in 2011-12. Slowdown in consumption expenditure suggests weakening demand in the economy.
The link between rates and inflation, especially when inflation is more from weak monsoons and suppressed prices is tenuous. Even rate hikes by the RBI will not bring down inflation nor will rate cuts raise inflation expectations.
On the liquidity front, RBI has been buying government bonds with bond purchase amounting to around Rs 80,000 crores in the April-July 2012 period. RBI’s bond purchases have helped system liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) to come off from over Rs 100,000 crores levels to levels of around Rs 50,000 crores. The central bank has maintained that it will use OMO (Open Market Operations) to infuse liquidity into the system if necessary. A reduction of SLR will not lead to liquidity easing in the system, as tight system liquidity is not due to banks buying of government bonds. The government has in fact aided liquidity as it is a net spender.
The stance of the RBI is dramatically opposite to the stance of central bankers around the world. Central banks from the Fed to the ECB are doing what they can to pull their economies from going down a slow growth path but at the same time they are warning their respective governments on fiscal consolidation. RBI has recognized the threats to growth from a “Fiscal Cliff” event in the US and a worsening of sovereign bond crisis in the Eurozone. RBI has also recognized the fact that markets are expecting both the Fed and the ECB to act strongly to bring about an easing of the growth and financial stability situation in their economies.
Is the RBI waiting for the effects of Fed, ECB and other global central banks to filter down to India?